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Uncertainty Traps

  • Mathieu Taschereau-Dumouchel

    (University of Pennsylvania - Wharton School)

  • Edouard Schaal

    (New York University)

  • Pablo Fajgelbaum

    (UCLA)

We develop a quantitative theory of endogenous uncertainty and business cycles. In the model, higher uncertainty about fundamentals discourages investment but agents can learn from the actions of others. Therefore, in times of low activity information flows slowly and uncertainty stays high, further discouraging investment. This creates room for uncertainty traps -- self-reinforcing episodes of high uncertainty and low activity. We characterize conditions that give rise to uncertainty traps. Negative shocks to average productivity or beliefs may have permanent effects on the level of activity through the persistence of uncertainty. We also characterize optimal policy interventions. The socially efficient allocation can be implemented with aggregate-beliefs dependent subsidies, but under certain conditions it necessarily features uncertainty traps. We embed these forces into a standard quantitative model of the business cycle to evaluate the impact of uncertainty traps.

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File URL: https://www.economicdynamics.org/meetpapers/2013/paper_677.pdf
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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 677.

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Date of creation: 2013
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Handle: RePEc:red:sed013:677
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Bachmann, Ruediger & Bayer, Christian, 2009. "Firm-specific productivity risk over the business cycle: facts and aggregate implications," Discussion Paper Series 1: Economic Studies 2009,15, Deutsche Bundesbank, Research Centre.
  2. Greg Kaplan & Guido Menzio, 2013. "Shopping Externalities and Self-Fulfilling Unemployment Fluctuations," Working Papers 1461, Princeton University, Department of Economics, Center for Economic Policy Studies..
  3. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2007. "Dynamic Global Games of Regime Change: Learning, Multiplicity, and the Timing of Attacks," Econometrica, Econometric Society, vol. 75(3), pages 711-756, 05.
  4. Christophe Chamley, 1999. "Coordinating Regime Switches," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 869-905.
  5. Chamley, Christophe & Gale, Douglas, 1994. "Information Revelation and Strategic Delay in a Model of Investment," Econometrica, Econometric Society, vol. 62(5), pages 1065-85, September.
  6. Francois Gourio & Anil K Kashyap, 2007. "Investment Spikes: New Facts And A General Equilibrium Exploration," Boston University - Department of Economics - Working Papers Series WP2007-006, Boston University - Department of Economics.
  7. R?diger Bachmann & Steffen Elstner & Eric R. Sims, 2013. "Uncertainty and Economic Activity: Evidence from Business Survey Data," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 217-49, April.
  8. Frankel, David M. & Pauzner, Ady, 2000. "Resolving Indeterminacy in Dynamic Settings: The Role of Shocks," Staff General Research Papers 11924, Iowa State University, Department of Economics.
  9. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
  10. Hernan Moscoso Boedo & Pablo D'Erasmo, 2013. "Intangibles and Endogenous Firm Volatility over the Business Cycle," 2013 Meeting Papers 97, Society for Economic Dynamics.
  11. Zheng Liu & Sylvain Leduc, 2013. "Uncertainty Shocks Are Aggregate Demand Shocks," 2013 Meeting Papers 270, Society for Economic Dynamics.
  12. repec:oup:restud:v:60:y:1993:i:4:p:777-94 is not listed on IDEAS
  13. Ruediger Bachmann & Giuseppe Moscarini, 2011. "Business Cycles and Endogenous Uncertainty," 2011 Meeting Papers 36, Society for Economic Dynamics.
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